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U.S. Export Rules in Question

Dispute over international trade agreements continues.

.S. taxation of profits companies make from exporting
goods has gone through several stages over the years. For a long time,
U.S. multinational corporations were able to set up and use foreign
subsidiaries whose income was free from U.S. income tax (as long as it
was not repatriated and brought back into this country). Corporations
set up offshore operations, through which the U.S. parent channeled
manufactured products.

CFCs. In the 1960s Congress decided to tax
some of this income when it was earned (rather than when it was
brought back into the United States), by taxing certain controlled
foreign corporations (CFCs). The CFC rules imposed tax on certain
types of income.

DISCs. In 1971 Congress decided it wanted to
promote exporting and keep U.S. manufacturing in this country. It
created the domestic international sales corporation (DISC), which, in
effect, exempted certain export-related income from corporate
taxation.

International controversy. With all these
changes in U.S. tax laws came disputes. What was then the European
Economic Community (EEC) claimed DISC rules violated trade agreements
between the United States and European countries. These claims led to
a settlement, with this country’s limiting the amounts of DISC income
it would allow to be deferred.

FSCs. In the 1980s Congress again changed the
laws governing foreign income. Believing that foreign tax laws
disadvantaged U.S. exporters, Congress set up the foreign sales
corporation (FSC) rules. If a foreign corporation (established in a
qualifying jurisdiction that met a number of requirements) elected FSC
treatment, a portion of the income earned from export sales was exempt
from U.S. taxation.

More problems. In 1995 the World Trade
Organization (WTO), of which this country is a member, was formed. It
set up a formal process to resolve trade disputes.

Once this dispute mechanism was in place, the EEC brought a
complaint against the United States for its FSC rules. The WTO
ultimately found this country to be in violation of the trade rules
and recommended it change its FSC laws to comply with all WTO
agreements. In April 2000 the United States indicated it would comply
with the ruling. Soon after, Congress repealed the FSC rules and
enacted a new set of rules governing certain foreign income.

ETI. In November 2000 the President signed the
new legislation, repealing the FSC rules and replacing them with
provisions that allowed U.S. taxpayers to exclude a portion of their
extraterritorial income (ETI) from their gross income.

Further questions. Despite Treasury’s attempts
to make the ETI provisions WTO-compliant, the European Union
challenged these rules, and in August 2001 the WTO again ruled against
the United States. This country appealed the decision in November
2001, but its efforts were denied in January 2002.

Based on this decision, the European Union will be allowed to
increase the tariffs on U.S. imports or request that this country
provide compensation by reducing its tariffs on European Union imports
to the U.S.

In addition, it is now up to the United States to change its laws
again and bring them into conformity with the trade agreements the WTO
felt were violated. Politically and economically, such actions will
not be accomplished easily.

For detailed discussions on the dispute and the new ETI legislation,
see “New Rules for Taxing Extraterritorial Income,” by David Benson
and John Kennedy, and the Tax Education column, by Wray Bradley, in
the May 2002 issue of The Tax Adviser.

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